On November 15, 2001, the Xbox sprung
fully armed from the loins of the most powerful software company on earth.
According to
Microsoft,
the launch of the gaming console has been the most successful debut in the
storied history of video gaming.

However, it is clear that the hardware costs
of the Xbox are substantial and our exclusive
peek inside the unit
supports the widely held belief that the software giant is losing money on each
unit.

A savvy Microsoft investor recently sent us a
message regarding his correspondence with investor relations for the
staggeringly wealthy new entrant in home gaming systems. In its response,
a Microsoft representative admits that the console itself delivers little to no
profits, but that money is to be made from software titles bought over the life
of the system.

The message in its entirety follows.

===================================

Attached is the response from MSFT IR about
the XBox. Basically, they tell me that the games get the "typical" SW margins.
I assume that to be somewhere on the order of 75-80% gross (not including R&D
costs) profits. So, from a gross margin perspective, they probably break
even if they sell 3.5 MSFT-developed titles per XBox. Add in
non-MSFT-developed titles and the above 3.5 # goes lower. (you cannot assume $50
for the revenue, of course -- $35-$40 ?).

(my commentary):
Of course, the XBox itself has far greater possibilities than just a game
system, as we well know. Also keep in mind that, when you buy the DVD
add-on and the extra controller, MSFT is getting pretty stinking good profits
there, too.

xx

-----Forwarded message-----

Hello xx,

We have only disclosed a limited amount of informaiton about the software
royalty business model primarily for competitive reasons. It is true that
the game hardware consoles are sold at a very small or negative margin.
The success of the business model depends on the number of game titles that we
can sell over the life of the Xbox.

Additionally:

- We had 19 game titles at launch, and should have over 30 by the end of the
holiday season
- We expect to have over 100 games available by the end of our fiscal year,
6/30/2002
- Over the period, we expect that approximately 1/3 of the games will be
produced by Microsoft, and 2/3 by third party publishers
- For first party titles, which retail for about $49 on average, you should
expect typically software type margins as the incremental costs to produce each
additional unit is small
- For third party titles, we earn a royalty per unit sold that is more or less
consistent and competitive with industry averages. The specific amounts are
confidential per the terms of the contracts with each individual game developer

I hope that this is helpful.

Thanks,
Microsoft Investor Relations

-----Original Message-----

Hi,

I am a Microsoft shareholder. I recently purchased an XBox, as it is, by
far, the superior performing game system on the market today. I understand
that Microsoft loses money (at least at present) on each XBox it sells. As
a shareholder, I would like to better understand how the software licensing
royalties. For instance, how much money does Microsoft receive for each
non-Microsoft developed XBox title sold? In addition, I would be
interested to know the approximate profit for each Microsoft-developed title, if
that is possible. I fully understand that the game market is just one of
the opportunities for XBox. Any and all information would be greatly
appreciated.